You are on page 1of 2

NB: This extract about Chile is from the World Bank’s September Mongolia Monthly Economic Update.

Box 1. Chile’s Fiscal Regime

Figure 1.1. How Chile’s structural balance rule stabilized
Prior to the introduction of its fiscal regime, Chile had the budget during the copper price boom and bust
suffered from a seemingly endless succession of 10 9000
Chile's fiscal balance (% of GDP)
mining booms and busts. However, starting in 2001, Chile's structural balance (% of GDP)
the Chilean Ministry of Finance adopted a structural Mongolia's fiscal balance (% of GDP)
balance rule, which limited the effects of cyclicality on Copper price (right axis) in $ per metric ton 7000
fiscal management (mining revenues are in the order
of 15 percent of total revenues) and improved the weak
public finances seen in the late 1990s. These 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 5000

weaknesses included a series of fiscal deficits, the -5

negative net worth of the Central Bank (undermined

by a large bailout of insolvent banks in the 1980s and -10
FX operations in the 1990s), foreign debt
vulnerabilities, and the large contingent liabilities -15 1000
associated with pensions and infrastructure
concessions. The new fiscal regime was needed to Source: World Bank, IMF, Central Bank of Chile and Mongolia
neutralize the fluctuations, but also had to be simple,
clearly defined and transparent, in order to provide maximum clarity on the fiscal situation and avoid manipulation.
The source of the fluctuations on fiscal revenues was threefold. First, whenever copper (and molybdenum) prices
went up, mining tax revenues went up. To neutralize the fluctuations, a long-term copper price projection was used,
instead of the actual price, to determine the “structural” mining revenues. If the actual mining price went above the
long-term price projection, the realized revenues would be saved, and not used in the current budget, and vice versa.
Second, whenever GDP fluctuated, non-mining tax revenues fluctuated. To neutralize this, a long term GDP growth
rate was estimated, and, similar to the mining tax revenue smoothing, a structural non-mining tax revenue stream
was created. Third, the return on governments’ financial assets fluctuated also, and a similar smoothing mechanism
was adopted.
In each year, the “structural” (not the actual) revenues would then set a limit on actual expenditures in such a way
that a specific fiscal balance would be achieved. The budget balance thus targeted is therefore called a structural
balance. Chile started out with a structural balance of 1 percent of GDP (a surplus). During the mining boom years
of the mid-2000s, this type of structural balance rule was in place. Chile’s actual fiscal surpluses would grow to8 or
9 percent of GDP, but expenditures would be limited as if the surplus were only 1 percent. The structural balance
target is reviewed every year, and in the case of Chile it was also revised downward several times to better respond
to the emerging economic trends. Currently, Chile is under a structural fiscal deficit rule of one half of a percent.

Chile’s fiscal responsibility law complements this regime by focusing on the management of the stock of financial
assets generated by the rule. The Pension Reserve Fund (PRF) and Social and Economic Stabilization Fund (ESSF)
were created and wholly invested abroad in order to shield the exchange rate and local financial asset markets from
the effects of fiscal portfolio growth. The fiscal responsibility law also permits the re-capitalization of the Central
Bank over 5 years and increases transparency of fiscal policy and financial asset management. The savings set aside
in the stabilization fund are used for two purposes only: to finance the fiscal deficit and/or repay public debt. The
investment strategy is conservative and mindful of the requirement to be liquid; invested mostly (70 percent) in
government bonds of the US, several EU states and Japan. The PRF receives 0.5 percent of GDP every year, with a
floor of 0.2 percent. The stabilization fund held about $25 billion in savings before the global crisis. Today, the
savings are down to $7 billion, because of the financing of the fiscal deficit caused by the stimulus package.
The structural balance rule effectively ended the boom and bust cycles, making budgeting more predictable and
sustainable. The recent external shock proved that Chile could weather the storm better than others with savings of
about one third of its GDP. While other countries in the region had to cut expenditures, Chile is now injecting funds
into the economy, including funds to protect the poor from the downturn. The Chilean fiscal stimulus package is
entirely domestically financed, and consists of 1 percent of GDP tax cuts, 1 percent increased current expenditures,
and 0.8 percent public investments. The policy of running large fiscal surpluses during the mining boom, which had
been controversial, has now been fully vindicated and legitimized by political polls.
Source: World Bank staff; Bloomberg; Budgets Bureau, Ministry of Finance of Chile